The Sequester Will Lift, Not Cut, Defense Costs

By Sara Sorcher

July 30, 2013

In retrospect, Bob Stevens was overselling. Last summer, to help motivate lawmakers to undo the sequester, Lockheed Martin’s then-CEO warned that the impending cuts might force him to lay off 10,000 of the defense giant’s 120,000 employees. That never happened. But Lockheed, which reported $39 billion in net sales last year from government contracts, supports a giant ecosystem of subcontractors that provide parts and technology for Pentagon programs. How would the budget cuts affect them?

Mapping that ecosystem would be virtually impossible (just last year, for instance, the Defense Department committed $360 billion on 14 million contracts), so National Journal decided to look at one program as a proxy: the F-35 Joint Strike Fighter, the country’s costliest weapon system. Like almost everything else in the defense budget, its contracts are subject to sequestration’s looming across-the-board cuts. The U.S. is already buying 409 fewer planes than the 2,852 originally planned and has delayed the production of an additional 179.

But even this program is too unwieldy for a systematic investigation. Lockheed, the lead contractor, makes the aircraft’s nose and wing, but Northrop Grumman makes the fuselage, BAE Systems builds the tail section, and Pratt & Whitney constructs the engines. Altogether, 32,500 people across 46 states work on the program. There are 1,400 companies directly supplying the four major contractors. Of those, 600 are considered small businesses.

So, to narrow the focus further, I traced a single set of components down the supply chain. Lockheed’s F-35 gets its engine from Pratt & Whitney, which uses metal bearings from New Hampshire Ball Bearings, which buys super-tough metal from a specialty steel mill in Pennsylvania—a Russian nesting doll of national security. Ball Aerospace, which supplies Lockheed with the plane’s antennae, and Faustson Tool, which makes the antennae housing, also gave perspective.

In the end, Lockheed can make fewer fighters and Pratt can make fewer engines than initially planned; they’re big companies with lots of revenue streams, and they’ll be fine. But the sequester will rattle smaller companies already toughening metals, crafting parts, and writing software for planes that won’t be ready for years. Some of these suppliers, analysts predict, will leave the defense industry or go out of business, imperiling the weapons they build. “With sequestration, what looks like modest cuts at the top of the system, down at the supplier level looks like the difference between life and death,” says Loren Thompson, chief operating officer of the Lexington Institute think tank and also a consultant to Lockheed. “It could be the difference between making and losing money for a small enterprise located far from the capital.”

Even for those that survive, the cutbacks will likely change the way they build their budgets, forcing them to reduce risk by raising costs—at taxpayer expense. Unexpected reductions will strain already-thin margins. If a company has prepared for more business, for instance, it may have invested in machines, buildings, staff, and even parking lots. Less volume means charging higher prices to defray those costs. It’s like a shared apartment: If one of three roommates moves out, the others still have to pay the same rent. They may need higher salaries to afford it.

The risk is not just monetary: These hard-to-trace supplier disruptions are an “insidious problem,” says Aerospace Industries Association President and CEO Marion Blakey, a problem that could eventually imperil the defense industrial base and its ability to meet the demand for weapons that national security experts say America needs. “None of us know when all of a sudden the slight tremors we’re feeling under our feet will prove to be a much bigger shift in … the ability of the industry to deliver,” she says.

Consider the companies in this story as a microcosm of the giant supply chain. Other businesses supplying the F-35—or more-vulnerable defense programs—are facing similar challenges. Once the Pentagon officially implements sequester cuts, contracting life will become even worse.